Sunday, 16 December, 2018

What A Yield Curve Inversion Means For Traders

Gold Bangles Global stocks dive on growth concerns, doubts over trade truce
Orlando Vargas | 08 December, 2018, 08:39

If that inversion happens, investors should prepare for a potential US recession as soon as mid-2019.

Here's what you should know about this unusual market phenomenon and what it's signaling about the economy.

Investors typically demand higher yields to commit money for longer periods of time.

Answer: The Fed kept hiking in the face of a slowing economy as the chart I posted shows. For its part, the central banks says that pushing up rates is necessary to keep the economy from overheating.

Oil prices pared some gains as fears flared that demand would stall due to a trade war between the U.S. and China, and that Russian Federation remained a stumbling block to a deal to cut global crude supply.

To be sure, this week's inversion has been limited so far to the front-end of the yield curve rather than more closely studied recession harbingers such as the gap between 2-year and 10-year note yields.

Japan's Nikkei dropped 0.8 percent and South Korea's KOSPI shed 0.5 percent.

The dollar has been under pressure since Federal Reserve Chairman Jerome Powell said last Wednesday that USA interest rates were nearing neutral levels, which markets interpreted as signalling a slowdown in the pace of rate hikes.

Bear in mind, I am not suggesting it is wrong for the Fed to hike.

"Today's move feels like the market is a scorned lover".

That has been a common view at the Fed, including among top officials like Chairman Jerome Powell.

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It added, "We would caution against reading too much into the inversion".

Simply, the yield curve tends to invert before economic downturns.

The theory may get a test soon.

The report argues that the rate differential between three-month bill and 10-year note was a more accurate indicator, and it remains far from inverting.

The 3-month to 10-year spread is now 0.492 percentage points.

In an "economic letter" published by the San Francisco office of the U.S. Federal Reserve (Fed), Michael D. Bauer and Thomas M. Mertens summarize the implications of an inversion succinctly: "Every U.S. recession in the past 60 years was preceded by a negative term spread, that is, an inverted yield curve".

Those worries on Tuesday saw two-year yields rising above those of longer-dated 5-year notes for the first time in more than a decade. Delaying the hike would reinforce the markets fear and prove that the Fed also fears a slowdown. It reflects "total bond market disbelief in the Federal Reserve's prior plans to raise rates through 2019", he told Reuters.

But markets are doubtful.

Last year's massive federal tax cut has bolstered business confidence, but trade tension between Washington and major USA trade partners looms as a possible economic drag, analysts said. Benchmark 10-year notes gained 13/32 in price to yield 2.966 percent the lowest since September 13.

While Fed officials have begun pointing to "headwinds" from slowing global growth and other risks, it won't be clear how much this has changed their outlook until they issue fresh economic projections after the December 18-19 policy meeting.

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